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Is pay for performance the best form of compensation?

Pay-for-performance is by far one of the most popular forms of compensation that employees can offer their workforce. But even with it’s popularity, the question of whether or not it is the best way to compensate employees remains. There are many ways to do it, but essentially pay-for-performance compensation means that a form of measurement is established and goals are set, then when employees meet a goal, they are compensated accordingly. This could be a number based on the amount of sales during a period of time, annual revenue, performance reviews or any number of other measurements. In fact, one of the most significant considerations in whether or not pay-for-performance compensation is the best idea for your business is the type of incentive payment you’re using.

The devil is in the details

The saying “the devil is in the details” has never been truer than when it comes to pay-for-performance. While some companies have seen enormous success, others have wasted time, energy and money trying to make it work, and the difference almost always lies in the details. There are a number of things to consider and they all play a part in how you formulate and execute a pay-for-performance system, including the decision of whether or not it’s the best option for your situation.

A significant portion of the success or failure of this compensation system lies with who will be receiving the incentive pay. After all, the premise of pay-for-performance is that employees are motivated to help the company achieve success because they in turn are positively impacted. So the big question is, will this new system motivate your employees? As you can imagine, it all depends on how much an employee stands to gain, and those whose base compensation is higher will naturally have the potential to make more as a bonus. For those who only have the potential to earn an insignificant amount, there is little motivation to go above and beyond. Knowing this, it’s easy to see why those in management or executive roles are more motivated to outperform than those in lower-level roles. However, according to Towers Watson’s “Using Targeted Incentives to Drive Sustainable Engagement,” pay for performance is the fourth most important driver of sustainable engagement for employees who have the possibility of earning bonuses that are more than 15 percent of their base pay.

Another important factor to consider is what your goals or measurements will be. The Institute for Corporate Productivity produced “Tying Pay to Performance,” a report that revealed that top-performing companies said their main motivation for offering pay-for-performance is to recognize and reward high performers, while lower-performing companies reported that their main motivation was to increase the likelihood of achieving corporate goals. For pay-for-performance to work, the measurements must represent a balance of both without being unachievable or insignificant. You must also find which measurements work for your specific industry, business and employee groups. For instance, one study showed that executives earning bonuses based on earnings-per-share measures were more successful than those earning bonuses based on total shareholder return. This is just one example of how the specific details of your pay-for-performance system are the deciding factors of whether or not it’s the best option for you. It may take some research and experimentation to determine how to make it work for your business, but it is a system that can be successful when implemented the right way.

What kind of pay-for-performance measures does your organization use? Let us know in the comments section below.

We really enjoyed your point about how pay-for-performance is about recognizing high performers. Achievement and recognition are huge motivators, this is a great point for managers thinking about retention strategies.

How cost effective and productive would you say it is for an organization to painstakingly document employee performance in order to justify giving the highest achievers 1% more of a base salary increase than the “average” employee, and 2.5% more than the lowest of the low achievers?

Interesting discussion. I currently find myself in a position where I am told “you all do the same work, so we’re adjusting salaries so you all make the same salary.” It matters not if you have more experience, a college education, professional certification, etc. Our HR department doesn’t “get” how demotivating this is to those of us who consistently go above and beyond. I would love to see this issue addressed. If I didn’t love my current job and enjoy the people I support, I would definitely be out the door! Fortunately – or unfortunately, as the case may be… Read more »

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